Business Environment and Strategic Management - Example

Business Environment and Strategic Management This report will attempt to relate fluctuations in the petroleum industry to the established financial principles pertaining to universal economic realities as described by Porters five forces model of business interactions. This will be supplemented by the PESTLE model, it order to explain eternal forces effecting organizations. While shifts in market conditions and commodity prices are ongoing, there are fundamental realities of the business world which will be expounded upon within this report that will characterize the functioning of industry in an abstract sense, and will thus be applicable to the industry in question. Under discussion will be the status of refineries, and the rate at which sales of these facilities occur. The disposition of these facilities will be used as an indicator for prevailing trends within the petroleum industry and the ways in which established economic principles inform these, and future changes. Prior to any detailed examination of the future of the petroleum industry, it is necessary to develop a specified understanding of the five forces model, in order to explore their effects upon this and similar industries. In its simplest form, the five forces model purports to describe the competitiveness of the marketplace (Small Business Information Series, 2011). It describes: Political, Economic, Socio-cultural, technological, legal, environmental – factors, attempting to describe the following: 1.) External factors influencing a firm. 2.) External factors subject to future change 3.) Exploit changes better than competitors. Porters Five Forces are as Follows: 1.) Barriers to entry. The first of the five forces relates to costs and obstacles that prevent new competitors from joining the established corporations that drive a particular industry or. These principles which control competition are themselves subject to even more basic principles, in this case economies of scale. This provides a barrier to the entry of new competitors due to the ability of a larger firm to establish an infrastructure that permits the manufacture of finished products at a lower per unit cost than a smaller, less solvent organization with fewer resources. This is a critical factor that limits the ability of upstarts to provide competition to established corporate giants. Unless special circumstances exist to provide unusually profitable circumstances (Brand loyalty, tariffs, etc). And these preferences are reliably manifested in a lower price. Price is compelling, but not the only force that constitutes a barrier to entry. Depending upon the item in question, perceptions of value are also a necessary consideration. Certain items, such as bubblegum or paper cups may represent disposable items that are rarely analyzed critically by consumers. There highly disposable goods are only subjected to critical scrutiny in case of conspicuous failure. Otherwise it is reasonable to predict that the consumer will simply seek the lowest price for these items. But the price is only one of several factors to consider with major purchases such as cars and houses. Quality and product longevity become factors in the case of major purchases. And while such realities are difficult to measure in absolute terms, but from the perspective of the consumer loyalty or trust becomes important. The buyer will seek out a brand name which is perceived to convey quality. And in this manner, brand identity becomes another barrier to entry: because a new upstart has no history, and in highly competitive markets (especially pertaining to major purchases) buyers will be reluctant to take a chance on an unproven source if loyalty already exists for an established entity that appears to have demonstrated its worth in the past. Other purely physical limitations preventing the entry of new entities into the marketplace are start up costs in the form of capital requirements. This is simply an issue of gaining the equipment and or production facilities necessary to begin operations within that industry. This may pose a limitation with respect to proprietary or copyrighted information or features. Modern high-end electronics may contain software or microchips that are under copyright. There are many other items of high technology which require significant technical expertise in order to manufacture than. Or in other cases, there may be questions of intellectual property that are highly restricted. A new company cannot simply start printing new Spiderman comic books, because the concept is the intellectual property of an established competitor within that industry, and this proprietary protection is a powerful theoretical barrier to would-be entrants. In addition, proprietary barriers act as legal weapons that can be used in litigation. In the case of intellectual property it is possible to interfere with the operation of pre-existing competitors that over-step boundaries. These relationships are dynamic, with the potential to harm rivals, as well as supporting the interests of established parties. There are some theories proposing the possibility of a sixth force relating to complementary effects of competition working in the benefit of established parties. And in the case of the first of the five forces, the barriers to entry exert a protective influence on the profitability of previously established entities forming the core of the industry. These interrelationships which may constitute an additional force will be explored later on in this report. Using the PESTLE model, the external factors can be represented as pre-existing firms, whether they will continue to dominate, or whether an upstart will emerge profitable depends on controlling the above factors that prevent entrance to the market. 2.) Power of suppliers. Another of the four essential inputs is connected to a fundamental force of the marketplace influenced by, and with the potential to influence all others. Those entities that supply raw materials or essential, prefabricated components using other products invariably possess a degree of control over the marketplace. There is no iPhone unless there is silicon in order to manufacture microchips. But many microchips themselves may be independently manufactured by additional agencies before they are later assembled as basal components into a product marketed to consumers. With respect to the petroleum industry, the average consumer does not simply buy crude oil, yet crude oil is the fundamental raw material upon which the petroleum industry is based. In most cases, suppliers of raw materials cannot sell directly to individual consumers; the average customer has no use for metal ore, or unprocessed crude taken straight out of geologic deposits. Yet those which furnish eventual finished products to consumers are dependent on these sources. So the suppliers are limited in that extent, yet also indispensable. The power of suppliers is of course determined in part by accessibility of their respective materials. How many suppliers are able to provide the material in question? Bargaining power which suppliers can exert depends in part upon whether they are needed for critical paths in the manufacturing process that cannot be accommodated any other way. For instance, for certain forms of combustion, natural gas is a viable substitute for petroleum. But the operations necessary to extract natural gas are highly specialized, and the only entities equipped to extract it in a way that is profitable are the oil companies already exist in most cases. Therefore, adding the new product of natural gas increases the bargaining power of a singular entity that can control both petroleum and gas. If there were a situation where a different company controlled natural gas than the company which controlled supplies of crude oil then it would be possible to do business with either separately. This would diminish the bargaining power of any single supplier. But a single supplier able to provide a wider range of products or materials is more difficult to circumvent. This relates to a secondary factor the bargaining power of suppliers; the ability to switch. Is it possible for a manufacturer to derive raw materials of similar or identical quality from a competitor? This diminishes the total bargaining power of suppliers in the absence of some form of collaboration. The number of alternatives available to manufacturers for a potential raw material is a critical determinant factor in the bargaining power of the suppliers within the marketplace, which will be expressed further with respect to the third of the five forces. But with respect to suppliers, the presence of alternatives and is a critical factor in determining competition amongst those suppliers. This is expressed through the concept of supplier concentration. This concept, supplier concentration represents the level of competition between suppliers for an industry, which parallels the competition among the core manufacturers for an industry. As expressed previously in the example concerning crude oil and natural gas, the more disparate suppliers which exist within the marketplace, the less power they have to control prices. A lower levels of concentration relates to a diverse marketplace with a variety of small entities able to supply raw materials to manufacturers at a range of prices and qualities. And lower levels of supplier concentration have the potential to favor manufacturers, because they can afford to be more selective in contract in highly specialized or expensive products are more likely to be controlled by a smaller number of entities. In this case, with higher supplier concentration, anyone who wants to manufacture products containing the materials furnished by these agencies is far more limited in their choices, and therefore the supplier can exert far greater control on the behavior of would-be clients. Competition is favored by lower supplier concentration, whereas higher supplier concentration favors competition among manufacturers (Thompson & Martin, 2010). It is apparent that when analyzing this – and other facets of the five forces model, there are interrelationships between each factor composing the marketplace. In this case, between concentration of suppliers and supplier competition. Adjusting the concentration/quantity of suppliers appears to have the effect of shifting the competition. With respect to the interrelationship between suppliers and manufacturers, another factor in this aspect of the marketplace is expenditure ratios. A professional supplier has an understanding of the finances for their major buyers, and an important aspect of the marketplace is the ratio of revenue a particular manufacturer is likely to spend with a particular supplier. The less money spent by the manufacturer for the materials furnished by the supplier, the less buying power the manufacturer has. If a given level of expenditure is less than that of the industry average than the business from that firm is less important to the supplier. All companies must dedicate themselves preferentially to their most proportionately dedicated customers. Using the PESTLE model, manufacturers are external to the suppliers, consolidation of either party into a higher concentration can change the balance of power. 3.) Threat from substitution. Will will throughout the marketplace, there are multiple opportunities for alternatives, and part of competition is seeking out alternative means and sources for essential resources. Substitutions within the marketplace are potentially many and varied, and this potential creates a vulnerability that can upset the financial balance of the old order. It is not simply a question of finding a new source of crude oil from a different company at a lower rate, whether it were possible to accomplish the same purpose with a different commodity altogether? This was the fate of the kerosene industry at the advent of electricity. It is not always a matter of price; as technology advances there will be situations where a new paradigm emerges permitting consumers and businesses to circumvent what was once an essential material to achieve a fundamental purpose in a new way. At this stage in history, it is extremely doubtful that a buggy whip manufacturer could turn a profit at any price, regardless of how efficient such a hypothetical operation could be run, or who supplied them. Even if natural gas could replace gasoline for certain purposes, it may not have a transformative effect on the marketplace, as long as the same companies control both. If an engineer were able to devise an engine that burns water, this would change. These major transformations in technology or lifestyle are inevitable, but it is also doubtful that they can be predicted in advance without insider information. Without unusual information it is very difficult for any business entity to reliably anticipate major technological transformations with enough advance notice to dominate the new industry (Rothaermel, 2012). This financial threat occurs at all levels of the marketplace, and does not necessarily require a paradigm shift. If a new operation is able to overcome the barriers to entry and provide similar products as competitors, then consumers will weigh the offers of substitutes against the reputation and or brand loyalty of pre-existing sources for goods and services. In the historical case of the Japanese auto industry, a product was provided substituting the offerings of traditional, American manufacturers in a way that permanently altered the automobile marketplace. With respect to substitutions, the factors which buyers must consider are driven by value as well as cost. If an alternative to a traditional service or commodity becomes available, potential consumers must evaluate price-performance. American automobiles have existed for decades, what advantages do Japanese cars have over them at the same price? Based on a perception of value, what is the price of switching? This represents the second factor comprising the financial forces underlying the threat of substitution. Switching costs. Regardless of whether or not a new option is cheaper, or of good value – there may be tangential consequences towards shifting to the alternative. Many phone companies for instance, have a contract policy for their services – which includes an early termination fee. As a consequence, a new company offering a slightly lower rate for self-service may find that their offerings are still not preferred even if they offer identical services – an early termination fee may apply which negates profitability, providing an inherent control against the threat from substitution. This principle is also indicative of interrelationships between different elements of the five forces; switching costs may also be considered a barrier to new entrants. The third element of this force – the buyer propensity to substitute also relates to barriers to entry. This third factor, the probability that customers will be willing to substitute is the inversion of the concept of brand loyalty. The other side of brand loyalty as a barrier to entry is the willingness of consumers to utilize a substitute when and if it becomes available. It brand loyalty is too low the threat of substitution would logically increase, and but it may be difficult to determine this in advance – if a competitor does not presently exist in the marketplace able to supply a particular need. In this respect, a forward thinking corporate operation could make use of these principles to determine what degree of threat they face. If the company is able and willing to attempt customer surveys concerning brand loyalty, it should then be possible to estimate the extent of the threat offered from a substitution. This potential may not be obvious before such a competing agency is in business, but this represents an opportunity to estimate vulnerability; if the vast majority of the businesss customers are extremely dissatisfied and have no loyalty, then the present revenue of that organization is only a result of buyers having nowhere else to go (David, 2009). And in this situation, the marketplace would be open to a competitor and the threat of substitution would be very high. The inverse correlation being that barriers to entry would be lower. Using the PESTLE model, established manufacturers will perceive new substitutes as external to themselves . Technological and legal changes are a factor which will permit new entrants to the market to take market share from the established firms. 4.) Power of buyers. The marketplace is a continuum, and many principles operate at different levels in different dimensions, such as the aforementioned example of the buyers propensity to substitute and its correlation with barriers to entry. With respect to the power of buyers, the identity of the buyers themselves represents a shifting landscape, in the same way that the suppliers do. Manufacturers represent suppliers from the perspective of a private consumer, just as processors of raw materials represents suppliers with manufacturers as the buyers. In the case of certain highly complex consumer goods, there may be further intervening levels of complexity with retail manufacturers buying from other manufacturers in order to assemble disparate items into a new package for retail sale. This is the case with many high-end electronics; such as offerings from Microsoft (Xbox), and to a lesser extent Norton. Different technical components may be produced by factories all over the world, and are later assembled in Europe or the United States for sale in those markets, after the companies in question procure individual components which themselves had to be manufactured from another facility, which itself served as the buyer to another entity that harvests and processes raw materials – acting as the supplier. Thus the identity of the buyer is a landscape of links in a chain, with each link representing a different level of the overall marketplace, but similar principles apply to buyers at multiple levels of this economic continuum. Many of the factors controlling the bargaining power of buyers represent inversions of those factors which influence suppliers. This is the case with buyer concentration, if the industry of those purchasing the products in question is more concentrated, then their bargaining power becomes greater as a result of the fact that the supplier has fewer options concerning who to sell materials to add a profitable rate. In a reversal of seller concentration, the more potential, disconnected buyers there are available then the weaker their position collectively becomes. If there were only a single oil company capable of refining petroleum in the entire world, their power would be immense – and would constrain the ability of oil producers to control prices, if there was only a singular entity they could sell to. Another factor relates to the number of units of a particular product which the buyer purchases from the seller, described as buyer volume. This volume is defined by how much of a particular product the buyer purchases from all sources, and what ratio they receive from any particular seller. The buyers influence is greater with the source from which they obtain the highest ratio of their product. Information of this sort becomes highly valuable during negotiations, and it is necessary for the seller to have comprehension of what level of product a potential buyer is capable of handling. This information is equally relevant from the perspective of the buyer. Buyer information is a term describing the level of information which potential purchasers have concerning the industry of their sellers. The more information businesses have concerning the other, the more informed decisions they are able to make. If a disparity exists in favor of one party, then that party has a pricing and negotiations advantage (Johnson et al. 2008). Substitution is also a factor with respect to the power of buyers as well as sellers. If a customer can always shop somewhere else for a product that accomplishes the same purpose, then the power of the buyer is increased at the expense of the seller. The extent to which perceivable differences in a product factor into the substitution potential, in addition to brand loyalty as discussed previously. Using the PESTLE model, this is the other side of the seller dimension, with suppliers external to the buyers. Moreover, buyers and sellers overlap from raw-materials, to manufacturers, to retail, and end-consumers. Buyers can serve in a seemingly identical capacity, yet be external to each other. Accurate information is essential in gaining an advantage over sellers, who are themselves buyers - down the chain from materials to finished goods. 5.) Industry Rivalry. All of these factors combine from the perspective of the manufacturer in order to determine rivalry. But rivalry determinants within a particular industry are themselves subject to internal elements which define the influence of this fifth and final force. From concentration represents the number of corporations within the industry, and their comparative size the lower this number – the less likely it is to be extremely competitive, because the largest companies will create a balance among themselves and dominate the market. But this balance can be broken by industry growth, a factor which represents the speed at which the marketplace is growing at time. In the marketplace is growing rapidly, then the potential exists for sales and profitability to also increase, and competition is less aggressive if all players within the industry are seeing increases in their profitability. Finally, there are functional limitations in the form of intermittent overcapacity. This is an acknowledgment of the inevitable fluctuations in product demand during the course of the fiscal cycle, and as demand changes this will place a strain on the manufacturers ability to efficiently produce products. If demand is too high, then there will be shortfalls in the ability of the company to deliver before they have a chance to expand their operations to meet the new growth. But if demand is too low, then manufacturing facilities may prove more costly than theyre worth if they are not incentivized to produce a certain number of products. If it costs $10,000 to run the assembly line for a day, but the amount of goods sold is equal to only half that, then the operation must be revised in order to remain sustainable. All these factors combine to define the extent of competition. Using the PESTLE model, the core of the industry becomes a house divided. Each firm is part of a whole, yet perceiving each other as external to themselves, while simultaneously negotiating with other external entities (suppliers) to exploit weaknesses that will allow them to redistribute the balance of power within the heart of the industry. Yet this temporary unity at the heart of an established industry could be termed a sixth force, in the interest of transient stability. Conclusions from the Current Oil Industry There is evidence of increases in refinery sales in recent years, this is largely a response to changing technologies, which alter the availability of oil. Conditions affecting suppliers appear to be driving some of the changes in the market, which appears to be the case with respect to a North American reservoir located between the Dakotas and southern Canada. The Bakken formation has attracted new refineries to be built nearby in order to exploit this resource. It is possible to assert that selloffs and changes in the distribution of oil refineries may be driven by increasing power from the perspective of the supplier. This trend granting more market to the suppliers for the time being favors the sell-off and redistribution of refineries; putting more influence in the hands of the suppliers. But this - like all aspects of the global marketplace, is subject to dynamic changes. References David, F.R. (2009). Strategic Management: Concepts and Cases. 12th ed. FT Prentice Hall. Johnson, G, Scholes, K. Whittington, R. (2008). Exploring Corporate Strategy. 8th ed. FT Prentice Hall. Pickrell, E. 2013. Where Refineries go to the oil. Chron.com. http://www.chron.com/business/energy/article/Where-refineries-go-to-the-oil-4396032.php. Accessed: 3/16/2014. Rothaermel, F. T. (2012). Strategic Management: Concepts and Cases. McGraw-Hill/Irwin. Small Business Information Series. 2011. Introduction to PESTLE analysis. © Housing Industry Association Limited ABN 99 004 631 752 Thompson, J. and Martin, F. (2010). Strategic Management: Awareness & Change. 6th ed. Cengage Learning EMEA. Read More